Explain the gains and losses of an importing country. Draw the supply-and-demand diagram for an importing country.
Using the graphs explain the gains and losses of an exporting country.
The meaning of tariff. Describe its economic effects.
The effects of a tariff
Tariff - Tax on goods produced abroad and sold domestically
Free trade: Domestic price = world price
Tariff on imports: Raises domestic price above world price (By the amount of the tariff)
Define an import quota. Compare its economic effects with those of a tariff.
An import quota- Means of restricting the quantity of imports through import licenses, either of a certain item or from a certain country. See also import restrictions.
Similarities with tariffs
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They both result in higher domestic prices, an increase in domestic production of the good and a decrease in imports. |
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Consumer surplus decreases by the same amount (for a tariff-equivalent quota). Producer surplus increases by the same amount. |
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Deadweight costs are the same. (If the quota rents are both captured by the importing country and not wasted on rent-seeking activities). |
Differences from tariffs
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Under an equivalent quota, the distribution of quota rents equivalent to the tariff revenue can vary. It can be given to domestic producers or importers, foreign governments or foreign producers, or auctioned and retained by the government. |
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In the longer run, a quota will impose larger distortions on an economy than would a tariff. When domestic demand increases, a tariff would allow the price to remain constant at the world price plus the tariff, and imports to increase. A quota will lead to a rising price, a constant level of imports, and larger deadweight costs. |
Determine the arguments people use to advocate trade restrictions.
The jobs argument - “Trade with other countries destroys domestic jobs”
(Free trade creates jobs at the same time that it destroys them)
The national-security argument - “The industry is vital for national security”
When there are legitimate concerns over national security
The infant-industry argument
- “New industries need temporary trade restriction to help them get started”
- Difficult to implement in practice
- The “temporary” policy – hard to remove
- Protection is not necessary for an infant industry to grow
The unfair-competition argument
- “Free trade is desirable only if all countries play by the same rules”
- Increase in total surplus for the country
The protection-as-a-bargaining-chip argument - “Trade restrictions can be useful when we bargain with our trading partners”. The threat may not work
Describe what happens to the gains from trade when a tax is imposed.
ANSWER: A tax causes a reduction in the gains from trade by raising the price the buyer pays and reducing the price the seller receives. Hence, it will reduce the total volume of trade. This causes a loss of consumer surplus and producer surplus referred to as deadweight loss. The tax will reduce the gains realized from some trades and will discourage other trades from being made at all.
The meaning of externality. Describe the types of externalities.
Definition: An externality is an effect of a purchase or use decision by one set of parties on others who did not have a choice and whose interests were not taken into account.
Classic example of a negative externality: pollution, generated by some productive enterprise, and affecting others who had no choice and were probably not taken nto account.
Example of a positive externality: Purchase a car of a certain model increases demand and thus availability for mechanics who know that kind of car, which improves the situation for others owning that model.
A positive externality is something that benefits society, but in such a way that the producer cannot fully profit from the gains made. A negative externality is something that costs the producer nothing, but is costly to society in general.
Examples of positive externalities are environmental clean-up and research. A cleaner environment certainly benefits society, but does not increase profits for the company responsible for it. Likewise, research and new technological developments create gains on which the company responsible for them cannot fully capitalize.
Negative externalities, unfortunately, are much more common. Pollution is a very common negative externality. A company that pollutes loses no money in doing so, but society must pay heavily to take care of the problem pollution caused.
Describe why externalities can make market outcomes inefficient. Use the graphs to explain.
Self-interested buyers and sellers neglect the external effects of their actions, so the market outcome is not efficient.
Another principle from Chapter 1:
Governments can sometimes improve market outcomes.
Pollution: A Negative Externality
Example of negative externality: Air pollution from a factory.
The firm does not bear the full cost of its production, and so will produce more than the socially efficient quantity.
How govt may improve the market outcome:
Impose a tax on the firm equal to the external cost of the pollution it generates
Other Examples of Negative Externalities
the neighbor’s barking dog
late-night stereo blasting from the dorm room next to yours
noise pollution from construction projects
talking on cell phone while driving makes the roads less safe for others
health risk to others from second-hand smoke
Positive Externalities from Education
A more educated population benefits society:
lower crime rates: educated people have more opportunities, so less likely to rob and steal
better government: educated people make better-informed voters
People do not consider these external benefits when deciding how much education to “purchase”
Result: market eq’m quantity of education too low
How govt may improve the market outcome:
subsidize cost of education